Monetary Watch December 2010: The Money Supply, a triple from here?

Michael Pollaro
, ContributorAn Austrian economist’s take on the financial markets & economyOpinions expressed by Forbes Contributors are their own.

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If these trends continue, it seems to us that the money creation activities of private banking institutions could become the most important dynamic on the monetary inflation front going forward. What's more, those double digit increases may be just a start.

To that subject we now turn…

A Willing Banking System Can Always Expand the Supply of Money

As we have discussed several times in this space, nothing supercharges a money supply more than a banking system willing to create money by pyramiding loans, investments and deposits on top of its excess reserves. The operative words here are willing banks, for a willing bank can always increase the supply of money.

It’s a common misconception that the banking system needs willing borrowers in order to expand the supply of money. We hear it every day, from one deflationist after another. It’s not true. It’s not willing borrowers we require but willing banks, for while it is true that even a willing bank can not create money by making loans without willing borrowers, it can always create money by buying securities. The fact is even in the depths of a recession a banking system flush with excess reserves is always in a position to pyramid up its deposit liabilities, to create Uncovered Money Substitutes, regardless of the demand for loans. And since the pyramiding up of those reserves is one of the primary ways banks make money, sooner or later, they'll do it, especially in a system where the Federal Reserve stands ready to bail them out of their mistakes.

Guess what banks are doing right now with their excess reserves? That’s right, they are creating money by buying securities.

Here’s the 10-year record in Bank Credit, all Commercial Banks, courtesy of the Federal Reserve Bank of St. Louis: